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Bubbles, bank credit and macroprudential policies

  • Derviz, Alexis

We explore the ability of a macroprudential policy instrument to dampen the consequences of equity mispricing (a bubble) and the correction thereof (the bubble bursting), as well as the consequences for real activity in a production economy. In our model, producers are financed by both bank debt and equity, and face a mix of systematic and idiosyncratic uncertainty. Positive/negative bubbles arise when prior public beliefs about the aggregate productivity of producers (business sentiment) become biased upwards/downwards. Economic activity in equilibrium is influenced by the bubble size. The presence of macroprudential policy is represented by a convex dependence of bank capital requirements on the quantity of uncollateralized credit. We find that this kind of policy is more successful in suppressing equity price swings than moderating output fluctuations. Economic activity declines with the introduction of a macroprudential instrument in this model, so that the ultimate welfare contribution of the latter would depend on the aggregate default costs. JEL Classification: G01, G21, G12, E22, D82

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Paper provided by European Central Bank in its series Working Paper Series with number 1551.

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Date of creation: Jun 2013
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Handle: RePEc:ecb:ecbwps:20131551
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  1. Olivier Jeanne & Anton Korinek, 2010. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," Working Paper Series WP10-12, Peterson Institute for International Economics.
  2. David Besanko & Anjan V. Thakor, 2004. "Competitive Equilibrium in the Credit Market under Asymmetric Information," Finance 0411045, EconWPA.
  3. Aoki, Kosuke & Proudman, James & Vlieghe, Gertjan, 2004. "House prices, consumption, and monetary policy: a financial accelerator approach," Journal of Financial Intermediation, Elsevier, vol. 13(4), pages 414-435, October.
  4. Emilia Bonaccorsi di Patti & Giovanni Dell & Ariccia#x2019, 2000. "Bank Competition and Firm Creation," Center for Financial Institutions Working Papers 00-20, Wharton School Center for Financial Institutions, University of Pennsylvania.
  5. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  6. Douglas W. Diamond & Raghuram G. Rajan, 1999. "A Theory of Bank Capital," NBER Working Papers 7431, National Bureau of Economic Research, Inc.
  7. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
  8. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, vol. 95(3), pages 739-764, June.
  9. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  10. Alexis Derviz & Jiri Podpiera, 2006. "Cross-Border Lending Contagion in Multinational Banks," Working Papers 2006/9, Czech National Bank, Research Department.
  11. Olivier Jeanne & Anton Korinek, 2013. "Macroprudential Regulation Versus Mopping Up After the Crash," NBER Working Papers 18675, National Bureau of Economic Research, Inc.
  12. Gregory DE WALQUE & Olivier PIERRARD & Abdelaziz ROUABAH, 2009. "Financial (in)stability, supervision and liquidity injections : a dynamic general equilibrium approach," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2009006, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  13. Dell'Ariccia, Giovanni & Marquez, Robert, 2004. "Information and bank credit allocation," Journal of Financial Economics, Elsevier, vol. 72(1), pages 185-214, April.
  14. Santomero, Anthony M, 1984. "Modeling the Banking Firm: A Survey," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(4), pages 576-602, November.
  15. repec:oup:restud:v:51:y:1984:i:3:p:393-414 is not listed on IDEAS
  16. Giovanni Dell'Ariccia, 2001. "Bank Competition and Firm Creation," IMF Working Papers 01/21, International Monetary Fund.
  17. Enrique G. Mendoza, 2010. "Sudden Stops, Financial Crises, and Leverage," American Economic Review, American Economic Association, vol. 100(5), pages 1941-66, December.
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